Mexico's peso stung by bets on U.S. rates

IraIosebashvili

Mexico's currency fell to a record against the dollar Monday, illustrating the downside of popular emerging-market trades at a time of anxiety about higher interest rates in the U.S.

Touted for years by Wall Street strategists and bond investor Bill Gross, the peso has failed to deliver even though Mexico stands to benefit from a strengthening U.S. economy.

The reason: The peso is relatively easy to trade. That has lured investors to the peso in the past, but now it has become a double-edged sword as money managers seek ways to bet against other emerging-market currencies such as the Russian ruble.

Many investors are wagering against the peso because they believe a rate increase by the Federal Reserve will drain money out of risky emerging markets and cause developing countries' currencies to weaken. Because it is difficult to place bets against many emerging-market currencies, the peso is bearing the brunt of investors' scramble for protection ahead of any move on rates.

"That's the frustrating thing if you're a peso bull," said Win Thin, a senior currency strategist at Brown Brothers Harriman. "The fundamentals are solid, but the currency still gets clobbered."

At one point Monday, one dollar bought 15.8636 pesos, according to data provider CQG. That is a record low for the Mexican peso against the dollar. In 1993, the government redenominated the currency after a damaging bout of inflation. Monday's level compares with 15.711 against the dollar late Thursday. Foreign-exchange markets were open Friday, but trading was thin due to the Fourth of July holiday in the U.S.

The peso is down more than 6% against the dollar in the year to date, compared with a 0.6% decline in the MSCI emerging-market currency index.

The surprising decline is the last example of how the reversal of extraordinarily accommodative central-bank policies, put in place during the 2008 financial crisis, is overriding economic fundamentals in foreign-exchange markets.

Mexico's official forecast calls for 2.2% to 3.2% economic growth in 2015. While that is lower than previous estimates by the government of President Enrique Peña Nieto, it points to faster growth than in other Latin American economies. The International Monetary Fund expects Brazil to contract by 1%, while Argentina's gross domestic product is pegged to fall 0.3%.

In June, Mr. Gross, now at Janus Capital Group Inc., said the peso is between 15% and 20% undervalued. Mr. Gross also lauded the peso's fundamentals last year, when he was at Pacific Investment Management Co.

"The peso's PR is pretty good, but the reality is somewhat less compelling," said Luis Maizel, co-founder and senior managing director at LM Capital Group LLC, which manages about $6 billion. Mr. Maizel bought the peso in 2012, when the new administration took office. He sold a year later and has avoided the currency since.

While many market watchers say the peso's ease of trade is a big contributor to the recent selloff, other factors also are at play.

Benito Berber, a Latin America strategist at Nomura, said the uncertainty following the Greek no vote also helped push down the peso on Monday.

With more than a third of local Mexican government bonds in the hands of foreigners, investors tend to use the currency market to hedge the risk of holding peso-denominated debt, "because they see the economy as positive and don't want to sell the bonds," he said. That puts downward pressure on the peso.

More lasting damage could be caused by the decline in the price of crude oil, one of Mexico's biggest exports, analysts said.

Mexico's central bank has taken steps to control the peso's decline. The Bank of Mexico has been in no hurry to raise interest rates, given the slower-than-expected economic growth and with inflation just below its 3% target. But the foreign-exchange commission, which includes central bank and finance officials, has taken other measures to support the peso.

Since March, the central bank has been selling $52 million a day to supply liquidity to the exchange market and auctions $200 million on days when the peso weakens 1.5% from the previous session. The conditional $200 million auctions have been triggered only twice since the mechanism was activated in December.

Write to Ira Iosebashvili at ira.iosebashvili@wsj.com and Anthony Harrup at anthony.harrup@wsj.com

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